Crash landing?

Sebastian Mullins

Growth expectations have significantly declined as the market adjusts to the implications of a potential ‘full-blown Trump’ presidency. Are there idiosyncratic factors at play, or is this the start of a Trump-cession? 

Market Outlook

The equity market rallied post inauguration as the market anticipated a more subdued Trump presidency, quickly pricing in all the positives of Trump’s policies of tax cuts and deregulation, seemingly ignoring the protectionist policies of immigration and trade. Only a month later, equities are selling off as Trump moved ahead with tariffs on the US’ three largest trading partners – 25% on Mexico & Canada and 20% on China (up from 10% at the start of the month). The S&P 500 fell 4.6% peak-to-trough during February, and now down 6% at the time of writing.

Investors are now grappling with whether they should be pricing a ’partial Trump’ or a ’full blown Trump’ presidency, which will have very different outcomes on the global economy and markets.

The aggressive policy mix under a potential ’full blown Trump‘ administration could lead to notable differences for the US economy compared to the rest of the world. Factors such as weakened trade, stalled investment decisions, and a general shock to consumer confidence are expected to drive many economies toward recession, leading to significant interest rate cuts globally. However, for the US, this policy mix could result in stagflation, where diminished growth coincides with rising inflation. The Peterson Institute estimates that an additional 10% import tariff across all goods might temporarily add about one percentage point to US inflation. Efforts to stimulate demand through large fiscal measures may soon confront a deteriorating supply side, compounded by higher tariffs that could further exacerbate goods inflation. This could push the US economy’s potential growth rate down to 1.5%, with a potential technical recession in between, before stimulus ultimately boosts growth heading into 2026.

Early indicators suggest these risks may be already occurring. Consumers are reportedly reacting negatively to uncertainty and higher price expectations, which could lead to reduced spending, while long-term inflation expectations are creeping up. This predicament will pose challenges for the Federal Reserve (Fed), which may find itself unable to adjust monetary policy in response to the stagflation, especially as other central banks are expected to lower their interest rates in 2025. Consequently, this could lead to a stronger dollar, as the Fed maintains its stance amidst rising inflationary pressures, complicating economic management and potentially inviting further criticism from the president.

Depending what kind of Trump we end up with, the outcome is either hikes due to a turbo-charged economy, or cuts due to a self-imposed Trump-cession. The market is currently pricing in another rate cut by June, with 100bps of total cuts between now and the end of 2026. The divergence in potential outcomes is extreme. While we can’t predict Trump, we can see what impact his policies are currently having. The recent -2.8% GDP Nowcast by the Atlanta Fed, suggests we’re already in the throes of recession.

However, this contraction is almost entirely driven by the recent surge in imports. This is similar to March 2022 when supply chain relief post-COVID led to a similar flood of imports. There are two explanations for this. Firstly, this could be due to tariff front-running, where businesses look to import as much as possible before tariffs go into effect. If this is the case, then this will be offset in inventories, either in the official GDP print or as an offsetting boost the following quarter. The second cause could be the recent uptick in physical gold imports into the US. Most investors trade gold futures on COMEX, which requires delivery at maturity. Given talk of a potential 10% tariff on all goods, gold traders front ran physical gold imports to ensure they had sufficient supply. Goldman Sachs assumes this accounts for USD $30bn of gold imports, relative to the usual sub-$5bn. This would not be included in the official GDP print as it will be offset by investments. For reference, the New York Fed’s Nowcast is still pointing to a strong 2.9% as at the end of February.

Now that’s not to say there wasn’t genuine weakness in the data. Personal consumption expenditure, which has been leading growth over the prior quarters, collapsed to 0%. This can be partly explained by big swings in durable goods, mostly vehicle purchases after the Californian wildfires, but is still concerning. The recent manufacturing PMI also pointed to weakness, with the employment index dropping down to 47.6 and new orders dropping to 48.6, all while prices paid increased to 62.4.

Our base case remains that the market was too sanguine post-inauguration and the reality is that growth and inflation (and by extension, markets) will be in a state of flux this year as investors try to grapple with Trump’s policies. We believe growth will slow this year, but only to trend or slightly below, before rebounding. Recession is not our base case. However, the risk remains that sequential dents to confidence leads to a loss of animal spirits which ultimately causes a deeper slowdown. All eyes will be on services PMIs and non farm payrolls to see potential confirmation of weakening.

Portfolio changes

We continue to favour equities as our preferred asset class, but remain cautious over a 1-3 month horizon. Over the month of February, we reduced equities by over 4%, ending the month at 33% delta-adjusted. Throughout the month we sold 3% from US equities, 0.5% from EU, Japan and US energy equities, along with our put options getting closer to being in the money. We added 1% to emerging market equities over the month. We believe China requires fiscal stimulus to revive its economy, as weak demand and tariff threats remain a headwind. However, the recent speech from Xi with Jack Ma points to a positive turn in the equity markets. Seemingly moving away from ‘Common Prosperity’, Xi announced removal of fines and a creation of an equal playing field between private and state-owned enterprises. We believe this will allow equities to re-rate higher, but we remain patient and wait for further information on stimulus before getting more excited. We continue to hold 10% notional in March S&P 500 5900-5300 put spreads, which are at the money at the end of February.

In credit, we took some profit on our Australian investment grade position after spreads tightened from 74bps to 62bps. This saw our overall credit allocation drop by 2%. We continue to favour Australian and European corporate credit, along with Australian and US securitised credit, but continue to shun US corporates in both investment grade and high yield.

In currencies, we reduced our foreign currency position by 2% by selling some of our long US Dollar (USD) position. We added to Japanese Yen (JPY) and British Pounds (GBP), but at the expense of the Euro (EUR). We are short-term cautious as USD weakness could continue. However, given our view on growth and inflation in the US, along with the potential for the Fed to be on pause and even perhaps having to hike in 2026, we remain positive on the USD medium term. We have upgraded our AUD outlook to neutral. With almost three rate cuts priced in for 2025, we don’t think there’s much downside to front end yields to drive the AUD further lower. We continue to like the JPY given cheap valuations, the strong growth and inflation outlook, and the potential for further hikes by the Bank of Japan. We prefer to play long JPY with short Euro (EUR) to lessen the carry alongside our view of tariff risks to the European economy.

Our duration position remains unchanged at the headline level at 1.85 years, but we adjusted our positions under the surface. We took profit on our front end Australian bond position, selling 0.3 years. We have held this position from when markets were only pricing in 1.5 rate cuts for 2025 and took profit once four rate cuts were priced. We shifted this duration over to the US, where we believed a potential growth slowdown would benefit government bonds. Most of this was in the belly and back end of the curve to trim our steepener position. Similarly, we trimmed out steepener position in Germany by shifting 0.15 years duration from the front end to the back end of the curve. Finally, we added 0.125 years to German inflation breakevens, as inflation remains sticky across the Eurozone. We continue to hold inflation protection in the US and Australia.

By Sebastian Mullins, head of multi-asset and fixed income